As the Federal Trade Commission (FTC) implements “the final rule” banning non-competes, businesses with sensitive intellectual property (IP) must look to alternative measures to safeguard it. Despite apprehension about the ability to protect valuable IP without restrictive non-competes, in “the final rule” (16 CFR Parts 910 and 912), the FTC aims to increase future reliance on non-disclosure agreements (NDAs).

The FTC postulates that when NDAs are used in conjunction with trade secrets and IP law, these less restrictive mechanisms can work together to offer adequate alternatives to protect confidential information without restricting competition within the market.¹ However, where IP’s value is derived from its confidential status, the absence of non-competes might still create new challenges, especially in jurisdictions where NDAs can be read as de facto non-competes.

The FTC defines non-competes as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person . . . or (2) operating a business in the United States.”²  Commenters to the FTC raised concerns that, in the absence of non-competes, trade secrets are at paramount risk of losing their inherent value because former employees will not be barred from relocating to competing employers with trade secrets in tow.³ These trade secrets, once disclosed to new employers, are stripped of their value.⁴ In a ripple effect, this encourages employers to limit access to trade secrets, in turn stifling intrafirm innovation and skills training.⁵

Such comments present valid concerns to the Commission: without non-competes, trade secrets, and other confidential IP can, in essence, only be protected retroactively once it has already lost its inherent value. Indeed, a trade secret “derives independent economic value from not being generally known to other persons who can obtain economic value from its disclosure or use . . . [and] is the subject of reasonable efforts to maintain its secrecy.”⁶ In stripping businesses of non-competes, the FTC has removed a prophylactic barrier used to prevent the loss of trade secrets and other confidential IP’s economic value.⁷

While non-competes proactively stopped employees from entering into roles in which confidentiality agreements could be breached, trade secret law only provides a retroactive, punitive solution. Further, trade secrets are protected only insofar as the confidentiality agreement executed by the employee/employer permits.⁸ Thus, an employer’s only remedy is a breach of contract or tort action after the trade secret has already been divulged.⁹

The Commission believes that these prophylactic benefits of non-competes contribute to restricted competition for labor, product, and service markets.¹⁰ Non-competes, it says, are “overbroad with respect to protecting trade secrets and other confidential information, because they enable employers to restrict a wide swath of beneficial competitive activity without respect to any alleged misconduct.”¹¹ The Commission reiterates throughout “the final rule” that, although non-competes have been used as a blunt instrument to proactively protect confidential IP, the negative externalities imposed by non-competes are the reason for its demise.¹² As a solution to protecting trade secrets and other confidential intellectual property following the sunset of non-competes, the Commission proffers the power of the NDA.

The Commission reiterates throughout the entirety of “the final rule” that NDAs provide employers with a well-established means of protecting their economic investments while not limiting competition in the same manner as non-competes.¹³ NDAs are already routinely used to protect trade secrets and other confidential IP.¹⁴ In fact, 95.6% of workers with non-competes are also already subject to an NDA.¹⁵  Instead of preventing competition, an NDA, as a contractual provision, functions to “protect trade secrets and other business information that has economic value.”¹⁶

The Commission concedes that standing alone, NDAs, patents, or trademarks do not provide employers with protective benefits equal to that of non-competes.¹⁷ When used together, however, the Commission finds that these contractual agreements legitimately protect intellectual property investments as well as human capital investments.¹⁸ The Commission points to states like North Dakota, Oklahoma, and California, that long ago banned non-competes and asserts that there is “no evidence that employers in these States have been unable to protect their investments (whether in human capital, physical capital, intangible assets, or otherwise) or have been disincentivized from making them to any discernible degree.”¹⁹ Thus, an employer implementing an NDA used in conjunction with trade secret and IP law might find that these mechanisms do not provide as much protection as a non-compete. However, NDAs “reasonably accomplish the same purposes as non-competes while burdening competition to a less significant degree.”²⁰ But, where does this leave broad NDAs that are read as de facto non-competes?

While overly broad NDAs do not explicitly prohibit employees from entering into work with a competing employer, they raise the same policy concerns that left non-competes on the chopping block.²¹ Where a confidentiality provision functions to prevent an employee from gaining employment with another employer within the same field, that provision is effectively a non-compete and, therefore, barred under “the final rule.”²² Whether a covenant will be read as a non-disclosure agreement or a non-compete is contingent on “case-by-case adjudication for whether [it] constitute[s] an unfair method of competition.”²³  NDAs can avoid interpretation as non-competes by not including “information that (1) arises from the worker's general training, knowledge, skill or experience, gained on the job or otherwise; or (2) is readily ascertainable to other employers or the general public.”²⁴

Despite the Commission’s notion that appropriately tailored NDAs are apt stand-ins for non-competes, some states have already garnered a reputation for striking down NDAs which are deemed de facto non-competes.²⁵ California is a leader amongst this cohort.²⁶ But, even in jurisdictions “that enforce reasonably tailored non[-]competes, courts have begun striking down confidentiality agreements in employment relationships that go too far beyond trade secrecy, finding them to be violations of state statutes or common-law rules restricting enforcement of noncompetes.”²⁷ Employers would be wise to look to a precedent where NDAs were read as de facto non-competes in order to determine if their confidentiality agreement is at risk of such treatment.²⁸

The Supreme Court of South Carolina has determined that if, upon review, non-disclosure agreements are “so broad as to effectively become non-compete agreements”²⁹ that “[w]hen pruned to their quintessence, they tend to accomplish the same results and should be treated accordingly.”³⁰ South Carolina case law supports the notion that where non-disclosure provisions impose the same limitation as non-competes, they will be unenforceable. The Court of Appeals of South Carolina struck down a non-disclosure provision that functioned as a non-compete because it lacked a reasonable time provision.³¹ The NDA was over-broad such that it prevented an employee from working in his respective field indefinitely, which offended the public policy of South Carolina.³² Similarly, a case out of the United States District Court for the District of South Carolina found that an NDA provision acted as a non-compete provision when it prevented an employee from engaging in employment similar to his previous role.³³

How should businesses looking to protect sensitive IP proceed following the eradication of non-competes? According to the Commission, the answer is to rely heavily on NDAs, while ensuring that the language of such NDAs cannot be read as de facto non-competes, perhaps a line too fine to draw. For guidance, the Commission suggests avoiding language in an NDA that would constitute the “three prongs—“prohibit,” “penalize,” and “function to prevent”—[which] are consistent with the current legal landscape governing whether a particular agreement is a non-compete.”³⁴

Businesses should be aware that precedent suggests that an NDA will function as a de facto non-compete when it defines the scope of confidential information so broadly as to prevent an employee from working in their respective field in perpetuity.³⁵ At a minimum, new or revised non-disclosure agreements should clearly circumvent language that would “prohibit, penalize or function to prevent a worker from switching jobs or starting a new business” and which would consequentially be read as a non-compete. It should be noted that “the final rule” will not prevent employers from adopting garden-variety NDAs; rather, it prohibits only NDAs that are so overbroad as to function to prevent a worker from seeking or accepting employment or operating a business.”³⁶

Despite the Commission’s somewhat ambiguous parameters for using NDAs to contractually secure confidential IP, NDAs have garnered a more favorable reputation than non-competes. “Historical wisdom among courts and commentators has been that confidentiality agreements are typically enforceable. Courts do not scrutinize them to the same degree as noncompetes.”³⁷ Further, NDAs can offer advantages to an employer that are not found under a non-compete. “In most states, NDAs are more enforceable than non-competes.”³⁸ Nondisclosure agreements encompass a broader scope of material beyond what is traditionally defined under trade secret laws and are “routinely enforced by courts.”³⁹

“The final rule” is slated for implementation on September 2, 2024. While the Commission supports a future reliance on the power of NDAs, it remains to be seen whether this increased reliance will eventually garner for NDAs the same scrutiny that non-competes grew to face. Looking forward, employers using NDAs should be wary of language that restricts employee mobility, lest such a provision be read by the courts as an unenforceable non-compete. Precedent would indicate that following the demise of non-competes, NDAs that do not restrict alternative employment for an employee may still serve as a less protective but useable means of safeguarding intellectual property.  

*This article was drafted with assistance from Olivia Lane, a student at Wake Forest School of Law and summer law clerk at Burr & Forman.

Footnotes

^{1 Non-Compete Clause Rule, 89 FR 38342, 38431.}

^{2 Id. at 38342.}

^{3 See Id. at 38427.}

^{4 Id.}

^{5 Id. at 38428.}

^{6 Uniform Trade Secrets Act with 1985 Amendments (Feb. 11, 1986) at sec. 1(4).}

^{7 Non-Compete Clause Rule, supra note 1, at 38427.}

^{8 Confold Pac., Inc. v. Polaris Indus., Inc., 433 F.3d 952, 959 (7th Cir. 2006).}

^{9 See Id.}

^{10 Non-Compete Clause Rule, supra note 1, at 38427.}

^{11 Non-Compete Clause Rule, supra note 1, at 38429.}

^{12 Non-Compete Clause Rule, supra note 1, at 38428.} 

^{13 Non-Compete Clause Rule, supra note 1, at 38428}

^{14 Non-Compete Clause Rule, supra note 1, at 38426.}

^{15 Natarajan Balasubramanian, Evan Starr, & Shotaro Yamaguchi, Employment Restrictions on Resource Transferability and Value Appropriation from Employees (Jan. 18, 2024), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3814403.}

^{16 See, e.g., Rachel S. Arnow-Richman et al., Supporting Market Accountability, Workplace Equity, and Fair Competition by Reining In Non-Disclosure Agreements, UC-Hastings Research Paper 2-6 (Jan. 2022), https://papers.ssrn.com/sol3/.?abstract_=.}

^{17 Non-Compete Clause Rule, supra note 1, at 38427.}

^{18 Non-Compete Clause Rule, supra note 1, at 38427.}

^{19 Non-Compete Clause Rule, supra note 1, at 38424.}

^{20 Non-Compete Clause Rule, supra note 1, at 38424.}

^{21 TLS Mgmt. & Mktg. Servs. v. Rodriguez-Toledo, 966 F.3d 46, 57 (1st Cir. 2020).}

^{22 Non-Compete Clause Rule, supra note 1, at 38365.}

^{23 Non-Compete Clause Rule, supra note 1, at 38365.}

^{24 Non-Compete Clause Rule, supra note 1, at 38365.}

^{25 U.S. Treasury Dep't, Report, The State of Labor Market Competition (Mar. 7, 2022).}